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VW dealer aid: How much is enough?

Buy-sell advisers skeptical payouts will be adequate

Volkswagen dealers are finally in line for some financial relief after watching their volumes, profits and franchise values pummeled by the automaker's diesel emissions scandal.

But will it be enough to cover what they've lost, and may still stand to lose?

The answer will become clearer over the next several weeks, as lawyers for dealers and VW finalize how to divvy up a compensation fund --worth more than $1.2 billion, according to Reuters -- among VW's roughly 650 U.S. retailers, following a preliminary agreement reached last week. The agreement also calls on VW to buy back used diesels that have clogged dealership lots for more than 11 months.

Individual dealer payouts will be based in part on dealership and market size, according to Hagens Berman, a law firm representing dealers in the VW litigation in a U.S. District Court in San Francisco, but the reported $1.2 billion package amounts to an average of about $1.8 million per dealer.

Such a payout would be a boon for VW dealers struggling to turn a profit amid a stop-sale on diesel models that accounted for 20 percent of sales -- and a large chunk of new-car profits -- before the scandal erupted in September.

Jason Kuhn, a VW dealer in Florida and leader of the six-member Dealer Investment Committee formed in March to pursue settlement talks with the factory (See story above), cheered the deal, saying he was "very, very confident that the dealer body as a whole will feel that this proposal is very generous and that VW has fully compensated the dealers."

Yet buy-sell advisers, and even some VW retailers, question whether the fund will be enough to fully address the scandal's impact.

Alan Haig, president of buy-sell advisory firm Haig Partners in Fort Lauderdale, Fla., says an average payout of $1.8 million would be enough to make up for lost profits or diminished franchise value, but not both.

With many VW stores struggling before the scandal, Haig has assigned VW dealerships a flat dollar value since last year, rather than the traditional multiple of earnings. By his method, VW stores are worth between $0 and $1.5 million today, compared with $250,000 to $2.5 million before the scandal.

The impact of lost business and profit comes on top of that decline. Haig says while diesels accounted for a fifth of VW's sales, they made up a larger share of dealers' new-car profits.

As a result, he said, an average payout of $1.8 million, is "not sufficient to pay for the loss in profits and the loss in franchise value."

Buy-sell adviser Erin Kerrigan said the proposed dealer settlements are a key step in moving past the scandal, but echoed Haig's analysis. She estimates VW dealers on average were making an annual profit of about $600,000 before the scandal, meaning an average $1.8 million payout represents three times normal earnings.

"On an average basis it seems fair, but it very much depends on how [the funds] are allocated and distributed, and that's just for the earnings," " said Kerrigan, managing director of Kerrigan Advisors in Irvine, Calif.

"In terms of the value of the business, if someone was planning to sell their dealership in the middle of this scandal, it's not enough," she said.

Steve Kalafer, a VW dealer and owner of the 17-franchise Flemington Car & Truck Country in Flemington, N.J., says more is riding on the settlement than just a payout.

An underappreciated risk of the whole VW fiasco, Kalafer says, is the potential exposure to civil and even criminal fraud liability stemming from dealers who have borrowed money from lenders to bankroll business plans underpinned by VW's projections, which involved the sale of illegally modified diesel vehicles.

"The likelihood is unknown, but the bottom line is that dealers made warranties and representations based on projections [by VW] that were fraudulently computed," Kalafer said, adding: "I'm hopeful that this settlement from VW will put that potential liability behind them."

The risk of such dealer liability is a "legitimate concern," says Anthony Sabino, a federal class-action expert and law professor at St. John's University in New York. A criminal fraud case against a dealer would be "an uphill battle for even the best prosecutor" but civil fraud charges would be easier to pursue, he said.

Dealers could avoid such liability if the court-approved settlement contained an injunction shielding dealers from claims, he said.

Ultimately, Sabino says, the size of the compensation fund is key.

"What really is going to make it work, unequivocally, is money," he said. "People will be more accepting of a broad-based settlement that provides injunctive relief if there's enough money on the table."

Declines in luxury-vehicle margins and sales in 2016 could mean lower values -- and less transaction activity -- for luxury-brand dealerships in the buy-sell market, two buy-sell advisers said.

In addition to margin and volume pressure, luxury-brand dealerships are experiencing a potential drag on values because of the pressure from some luxury-brand automakers to upgrade stores to new image requirements.

"Fewer buyers are comfortable paying the high prices demanded by sellers of top luxury, particularly as luxury sales and margins come under pressure and luxury manufacturers demand expensive facility upgrades," Erin Kerrigan, a buy-sell adviser in Irvine, Calif., said last week in her second-quarter Blue Sky Report.

Kerrigan: Image programs’ cost can hurt values.

Alan Haig, president of Haig Partners, a buy-sell advisory firm in Fort Lauderdale, Fla., also questioned the outlook for luxury-brand stores in the buy-sell market in his second-quarter Haig Report.

While Haig expects stable blue-sky multiples for most midline import and domestic-brand franchises, "the outlook for premium luxury brands is a little cloudier," Haig said. As profits at those stores started falling in late 2015, "some buyers began to question why these franchises should bring valuations that were so much higher than nonluxury franchises."

Blue sky is the intangible value of a store beyond its physical assets and can vary enormously depending on an individual store's circumstances.

Dealership image requirements are part of the equation. Kerrigan, in her most recent report, slightly lowered her estimate of blue-sky multiples for BMW and Jaguar Land Rover in part because of increased dealership costs driven by expensive new image program requirements.

In March, Haig lowered his multiple estimates for BMW and Audi in part because of the expensive upgrades being required.

"Dealers tell us they are dismayed by the cost of the facility requirements demanded from some of these OEMs," Haig said.

In his most recent report, Haig lowered multiple estimates slightly for Mercedes-Benz stores.

The cost of any necessary store upgrades is always a big factor when evaluating a dealership for sale, said John Davis, a partner in the dealership practice at accounting firm Dixon Hughes Goodman. As sales plateau, as is now happening, "you do have to look harder at expenses."

Though there may be more concern about dealership expenses and the high cost of luxury-brand stores, it's unlikely to lead to significant price reductions for dealerships, the buy-sell advisers said.

Owners of top luxury-brand stores are unlikely to accept significantly lower multiples, Kerrigan said. "Thus, fewer top luxury franchises are likely to trade in the near term."

Because there are still relatively few luxury-brand stores, buyers tend to "stretch on price with the belief that they will be attractive long-term investments," Haig said. "Despite recent challenges in the premium luxury segment, we have seen only minimal movement in the prices of these stores."

For the overall buy-sell market, the number of transactions declined in the first half of 2016, Kerrigan and Haig reported. Values and demand for domestic-brand stores continue to be strong, although Kerrigan lowered her multiple estimate for Fiat Chrysler Automobiles brands after FCA acknowledged that it had misreported sales.

Kerrigan and Haig report more transactions involving multistore groups. That trend is likely to continue. Multistore transactions increased 52 percent during the first half of 2016, Kerrigan said, while the total of completed transactions dropped 17 percent. Multistore transactions now represent 30 percent of the buy-sell market, double 2015's level, she said.